Network positions: Strategic Alliance in the Tobacco Industry in | Ciencias Económicas | Pág 17-26

Network positions: Strategic Alliance in the Tobacco Industry in Nicaragua

Reynaldo Gómez García1

1 Magister Scientiae en Economía Política en la Universidad Nacional de Costa Rica. Profesor Titular de la UNAN-Managua / FAREM-Estelí. E-mail: [email protected]

ABSTRACT

This paper is based on the theory of the organizations as a network. I study the strategic alliances in the tobacco industry in Nicaragua. The study is more theoretical than empirical. I work with approaches in this field and any data of Central Bank of Nicaragua. My objective is to demonstrate that the firms in the tobacco industry are prone to enter in strategic alliances.

Keywords: Network Positions, Strategic Alliances, crowding positions, Tobacco Industry.

RESUMEN

Este artículo está basado en la teoría de las organizaciones como una red. Estudio la alianza estratégica en la industria del tabaco en Nicaragua. El estudio es más teórico que empírico. Trabajo con los enfoques existentes en la temática y algunas estadísticas del Banco Central de Nicaragua. El objetivo es demostrar que las empresas en la industria del tabaco están propensas a entrar en una alianza estratégica.

Palabras clave: Posiciones de redes, alianzas estratégicas, posiciones de hacinamiento, industria del tabaco.

17 Revista Científica de FAREM-Estelí. Medio ambiente, tecnología y desarrollo humano. Nº 10 | Año 3 | Abril-Junio 2014.

INTRODUCTION FRAMEWORK

Strategic alliances have become a topic of considerable Network form organization interest to scholars of organizations, because alliances are now prevalent in many industries, and they Prior to the middle 1970s, economists had largely inherently challenge the notion that organization are regarded the organization as a black box that is to discretely bounded entities, researchers have labored be understood as a production function converting to understand the antecedent conditions that lead to inputs to outputs. In the middle 1970s and early interfirm collaboration (Stuart, 1998). In the tobacco 1980s, economists started to look inside the black industry in Nicaragua has been a strategy alliance box, and two perspectives in particular became quite since the late 90´s. prominent: principal agent theory and transaction cost economics. At least when they first emerged, each Two central questions lead this paper. The first one, perspective was grounded in a dichotomous view of what motivates tobacco companies to form strategic economic organization: markets and hierarchies. alliances? The characteristics of organizations, such as their size or financial condition, predispose firms From a purely structural perspective, the trichotomy toward or against engaging in certain actions. In among market, hierarchy, and network forms of empirical work a variety of firms attributes, including organization are a false one. Markets and hierarchies size, age, scope, and resource endowments affect are simply two pure types of organization that can the propensity to enter into alliances. The second be represented with the basic network. Each market question, how does the tobacco company position in actor is a node that lacks any ties to the other actors the industry affect its propensity to enter in strategic or nodes. A hierarchy is a centralized network in which alliances? Alliances are driven in large part by the the vast majority of ties flow to or from one particular opportunities tied to a firm’s position in its external node. In effect, from a structural perspective, every environment. The firms will enter alliances only form of organization is a network, and market and when they possess exchange partners with whom hierarchy are simply two manifestations of the broader they forecast a high probability of a strategically or type. financially beneficial collaboration, and the availability of such partners is very often the binding constraint on A network form of organization as any collection of alliance formations. actors (N≥2) that pursue repeated, enduring exchange relations with one another and, at the same time, lack Although the tobacco industry in Nicaragua is very a legitimate organizational authority to arbitrate and important, there are no papers that address the issue resolve disputes that may arise during the exchange of strategic alliances. My hypothesis is that crowding (Podolny and Page, 1998). The network form is a form positions affects the industry´s propensity to enter into of governance. strategic alliance. From the perspective, I point out a case that led to the formation of alliances in the last This definition of a network form of organization decade. includes a wide array of joint ventures, strategic alliances, business groups, franchises, research consortia, relational contracts, and outsourcing agreements. This definition excludes most pure market arrangements such as short term contracts or

18 Network positions: Strategic Alliance in the Tobacco Industry in Nicaragua | Ciencias Económicas | Pág 17-26 spot market transactions, and it excludes employment quality. By fostering greater communication than relations. the market does, network forms of organization facilitate greater coordination in the face of The social network approach views organizations in changes whose significance cannot be completely society as a system of objects (e.g. people, groups, conveyed or understood through price signals. organizations) joined by a variety of relationships. Not • Others benefits. The resource dependence all pairs of objects are directly joined, and some are can alleviate sources of external constraint or joined by multiple relationships. Network analysis is uncertainty by strengthening their relationship with concerned with the structure and patterning of these the particular sources of dependence and small relationships and seeks to identify both their causes firm networks provide individuals with greater and consequences (Tichy et al, 1979). autonomy, lead to less inequality in the distribution of wealth, and foster a greater sense of community. Functions of network organization Strategic interdependence The network forms allow participating firms to learn new skills or acquire knowledge, gain legitimacy, The strategic interdependence between organizations improve economic performance, and manage resource describes a situation in which one organization dependencies. It considers each of these proposed has resources or capabilities beneficial to but not advantages separately: possessed by the other. Many organizations face such interdependence, because of their need for resources- • Learning. Network forms of organization foster not only money, but also resources such as specialized learning because they preserve greater diversity skills, access to particular kinds of markets, and the of search routines than hierarchies and they like (Gulati quoiting to Aiken and Hage, 1968). convey richer, more complex information than the market. First, they can encourage learning A strategic interdependence perspective on alliance by promoting the rapid transfer of self-contained formation suggests that firms will ally with those with pieces of information. The network ties are whom they share the greatest interdependence. This conduits or channels. Second, may foster learning proposition has been explored at numerous levels by encouraging novel syntheses of information of analysis. The role of resource contingencies is that are qualitatively distinct from the information an important predictor of a firm’s proclivity to enter that previously resided within the distinct nodes. alliances. The network becomes the locus of innovation. • Legitimation and status. If an actor partner Alliance formation and social structure in a network form of organization possesses considerable legitimacy or status, then the actor An alliance is any voluntarily initiated interfirm may derive legitimacy or status through the cooperative agreement that involves exchange affiliation. This has a number of positive economic sharing, or codevelopment, and it can include benefits for the actor, ranging from survival to contributions by partners of capital, technology, or organizational growth to profitability. firm-specific assets (Gulati, 1995). The social network • Economics benefits. In elaborating functions of alliances is dynamic and evolves as new alliances by the network form of organization is important are formed. A firm’s position in the network is thus the the direct economic benefits in terms of costs and result of both its own past alliances and those of other

19 Revista Científica de FAREM-Estelí. Medio ambiente, tecnología y desarrollo humano. Nº 10 | Año 3 | Abril-Junio 2014. firms in the network. Since new ties alter the very as drivers of alliances, but ignores factors that may social network that moderates their formation, there is lead to the availability of alliance opportunities in the an active interplay between action and structure in this first place. framework that is best observed over time. The social structural model in figure 2 points to the Discovering new alliance opportunities and finding an important role of social networks in guiding firms’ appropriate partner that desires an alliance requires actions. The social network of prior alliances is an very good access to market information. Firms need to active network of information exchange in which firms know about the reliability of potential partners as well. learn about the reliability and specific capabilities of Information thus has a twofold purpose, it makes firms current and potential partners. This exchange reveals aware of viable partners, and it serves as a basis for to firms alliance opportunities they would be unaware trust between partners. Firms can learn about potential of otherwise. alliance opportunities from many sources, and one important source is their network of prior alliance.

The social structure guides firms’ alliance decisions can be understood by examining both the riskiness of alliances and the organizational processes that underlie alliance decisions. First, it makes potential partners aware of each other’s existence. Through such networks firms learn about each other’s existence and also each other’s needs, capabilities, and alliance Figure 2: Social structural theory for alliance formation requirements at a given time. (Gulati, 1995)

There are two different theoretical explanations for The feedback loop from action to social structure in firms’ actions. In figure 1, information is depicted as figure 2 indicates the dynamic and iterative relationship freely available and equally accessible to all actors. of two factors over time in the current context: New Firms in such a context are rational actors that are alliances alter the social structure that influenced their aware of the strategic interdependencies they face creation. and systematically identify partners through whom they can resolve those interdependencies. Two distinct components of social structure are relevant:

Figure 1: Structure interdependence theory of alliance • The relational component of social structure formation (Gulati, 1995) provides direct experience based knowledge about current and prior alliance partners; The strategic actions of firms are the outcomes • The structural component provides indirect of matches between their competencies and knowledge about potential partners that firms new opportunities. Current and desirable future obtain from prior partners, their partners, and the competencies are the primary basis for strategic latter’s partners, and so on. interdependence between firms. The perspective is focusing exclusively on strategic interdependencies The relational and structural components of social structure are influential in alliance formation.

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Alliances with private benefits, common benefits technology. Firm A will have the opportunity to use and relative scope what it learns from firm B (regarding marketing products in firm B’s country) to market other products There are two different kinds of benefits available to that it is capable of producing, the more so the more participants in learning alliances (Khana et al, 1998): transferable this marketing knowledge is to these other products. Similarly, firm B can use its product • Private benefits are those that a firm can earn knowledge gained from firm A in other product or unilaterally by picking up skills from its partner geographic markets beyond the scope of the alliance. and applying them to its own operations in areas unrelated to the alliance activities. Strategic learning behavior • Common benefits are those that accrue to each partner in an alliance from the collective application The learning process postulated in these economic of the learning that both firms go through as a models is that a firm earns private benefits as soon consequence of being part of the alliance; these as it has learned enough to apply this learning to are obtained from operations in areas of the firm its operations (benefits being earned following the that are related to the alliance. completion of some amount of learning). Common benefits, however, are available only once both The scope of the alliance refers to a need that both partners have learned enough to be able to creatively partner firms have agreed to target (the introduction synthesize their knowledge bases (this synthesis of a new product or the provision of a new service), is only likely to occur after each firm completes its typically corresponding to some subset of markets in learning). Thus, private benefits are realized by a firm which the firms are themselves involved. The overlap prior to common benefits being realized by both firms. between the scope of the alliance and the total market scope of each partner is likely to vary and influence the All firms must finish learning in order for any of them to available private and common benefits. The greater derive the common benefits. Thus, there is no incentive the overlap between alliance scope and firm scope, for firms to try to get ahead of each other, or totry the higher are the common benefits and the lower are and finish learning in an effort to reap private benefits the private benefits. before their partners have finished learning. In such a situation of pure cooperation, resource allocation The figure 3 depicts this link between relative scope decisions are best made jointly. Both firms agree on and the nature of benefits. the amount of resources that it is optimal to allocate given the particular stage of the learning process; in effect, for the purposes of resource allocation, they act Figure 3: Schematic for argument (Khana et al, 1998) exactly as one firm would.

Consider an alliance from which the partners can earn Consider an alliance between technologically only private benefits. The firms set out to access each advanced firms A with a firm B in a developing country other’s knowledge but there is no common purpose with the objective of introducing a product P that A is to which they expect this knowledge to be applied. familiar with into B’s country. Here firm A tries to learn Instead, each firm wishes to access the knowledge of about the market for P in the developing country from the other in order to apply it to situations in which it firm B, while firm B tries to access firm A’s superior can reap benefits that accrue only to it, and not to its

21 Revista Científica de FAREM-Estelí. Medio ambiente, tecnología y desarrollo humano. Nº 10 | Año 3 | Abril-Junio 2014. partner. In such a situation, once one firm has learned reliable, inexpensive information about the quality and enough from its partner, it has no incentive to continue trustworthiness of the actors in a network. According to incur the costs of staying in the alliance (since there to Gulati (Stuart, 1998) in empirical work on alliances, are no common benefits, which only accrue once both the patterned diffusion of information about potential firms have finished learning, to continue to hold out for), alliance partners through the existing intercorporate and the firm will choose to terminate its involvement. network is viewed as the mechanism that connects an Knowing this, each firm wishes to avoid being in the established alliance network to the formation of new situation of being the laggard in the learning process; business associations. in effect, a situation of pure private benefits causes firms to race against each other. Although theoretical discussions of embeddedness theory have been broadly concerned with how social The behavior patterns sketched out for pure common and economic structures affect economic exchanges, benefits on the one hand, and for pure private benefits empirical strategic alliance studies in this tradition have on the other, represent extremes. Most alliances lie attended to the much more limited question of whether between these extremes; firms expect both private and how interorganizational alliance networks, once and common benefits, and exhibit behavior patterns formed, shape the establishment of relationships in that are an amalgam of those associated with the future periods. Because the causal motor in these extremes. The lower the ratio of private to common studies has been the circumscribed diffusion of benefits, the closer an alliance approximates pure information through the network of prior cooperative cooperation and jointly profit maximizing resource activity, questions such as how newly founded allocation, and the less the resource allocation differs organizations, new entrants into an industry, and firms from the optimal pattern under unilateral learning. that have not previously formed alliances gain first Khanna et al (1998) have established that a firm’s entry into the alliance network have been outside the propensity to engage in competitive racing behavior purview of extant, empirical embeddedness studies. in the context of a particular alliance may be related to activities of the firms that are not within the scope of the Alliances are volitional relationships; a lack of access alliance. Further, since the firm’s resource allocation to a good set of willing exchange partners is a limitation at a point in time is determined by its expectations of on many organizations’ ability to put into place a forthcoming private and common benefits (conditional productive cooperative strategy. The originators of on its own estimation of its learning and that of its intercorporate relationships are the factors that create partner). opportunities for profitable associations, and the lack of these opportunities is the constraint on alliance Network positions and alliances opportunity entry.

Network theorists have investigated the structural Unlike network theorists, Stuart (1998) focus in antecedents of interfirm alliances. Scholars working network position (high technology industry) approach within the embeddedness perspective associated for two reasons: with Granovetter (Stuart, 1998) have argued that • Because prior alliance activity is not a prerequisite an established network of interorganizational for collaboration in the empirical models (although relationships is a resource that facilitates the prior innovative activity is a precondition). establishment and governance of future alliances. • Because it influences whether, when, and to The central idea is that social ties convey access to what extent firms have opportunities to establish beneficial strategic alliances. 22 Network positions: Strategic Alliance in the Tobacco Industry in Nicaragua | Ciencias Económicas | Pág 17-26

Two dimensions of technological positioning, crowding • Distance between two firms in their technological and prestige, underpin the paper’s theoretical foci can interfere with their ability to collaborate argument and the empirical models. Organizations effectively. As a general rule, organizations are occupy crowded technological positions when many better able to evaluate and internalize the know- other firms concentrate in their areas of technological how of technologically similar firms. specialty and so are undifferentiated from them. • Effort is continuously duplicated within them as undifferentiated firms independently invest in the When organizations occupy crowded positions, development of related technologies. it is because many of the technological areas in • They have an established presence in the which they participate are concurrently pursued by technologies that represent one of the centers many competitors. The figure 4 portrays the uneven of activity in a market; other organizations may population density of organizations across the regions seek access to firms in technologically crowded of the two-dimensional technology space of the positions for the purpose of functionally integrating, semiconductor industry in 1991. bundling, or otherwise associating their products with one of a market’s core products.

Technological prestige influences alliance formations because it affects the number of partners available to a firm and an organization’s ability to secure favorable terms in alliance contract negotiations. Prestigious organizations are desirable associates because their strategic undertakings are focal points that draw the attention of external resource holders. Hence, potential customers and employees, the financial community, as well as the media and trade press are likely to become attentive to the initiatives of the affiliates of well-regarded firms. In this way, attention is directed and status is conveyed through interorganizational Figure 4: Dispersion of semiconductor firms in technology associations. As a result, a firm’s reputation and its space (Stuart, 1998). ability to mobilize resources are likely to improve when it formalizes an alliance with a high-prestige partner. The image conveys the fact that the semiconductor firms were irregularly dispersed across the EMPIRICAL technological landscape of the industry: a swarm of competitors converged around some organizations, Strategic Alliances in Tobacco Industry in while other firms were relatively distant from their Nicaragua nearest competitors. Once aboard the theoretical relation to the organizations For three reasons the firms in crowded technological as a network. I focus on the study of the tobacco positions will form alliances more frequently than industry in Nicaragua. Among the tobacco products otherwise comparable organizations that make their are derived (BCN, Revista de comercio exterior 2011): living in relatively unpopulated areas of technology: the cigarettes, , pipe mixture, snuff of chewing

23 Revista Científica de FAREM-Estelí. Medio ambiente, tecnología y desarrollo humano. Nº 10 | Año 3 | Abril-Junio 2014. and snuff power. I make more reference to the cigars In the last decade, the tobacco of Nicaragua has companies. improved markedly in quality. So that, the cigars export has increased. Nicaragua is the country with fastest Currently tobacco is producing in the departments of growth in the United State of America (US) market, Estelí and Nueva Segovia (more than 80% percent after Dominican Republic and . The cigars of production). Another area, but to a lesser extent export in the last six years can be seen in the figure 6. is the Ometepe island. Funding for the production of tobacco branch is given by trading companies, which provide the necessary resources to producers to cover production costs. Then, this production is bought entirely by those companies. In free trade mode, there were 10 companies, which in 2003 export $ 13.5 million (figure 5) and are located mostly in the department of Estelí. Three companies export 70 per cent of national production.

Figure 6: Cigars Export (BCN, Exportaciones fob)

According with the date from the Central Bank of Nicaragua (BCN in Spanish), Cigars export decreased in 2008 due to the international crisis. Although, how percentage of the total exports, its decreasing is greater in 2010 as shown as in figure 7.

Figure 5: Export and average price of tobacco branch (BCN, Revista de comercio exterior, 2011)

The most common variety of tobacco in Nicaragua is known like Habano, because it is from , but there is a variety Connecticut in smaller proportion. Although the tobacco industry in Nicaragua dates back to the 60´s, the first attempt to form alliances start in 1997 with the Association for Nicaraguan Cigars, in order to Figure 7: Cigars export between total exports (BCN, create stability in the tobacco industry. That effort was Exportaciones fob) maintained, but until 2006 the initiative was revived and reactivated the association. In 1997 was the boom of Currently the association is composed approximately the prices of the tobacco, but in 1998 the prices began 20 organizations. They are the largest manufacturing to the fall, the sales fell and every company is looking tobacco industry of Nicaragua, located in Estelí such as for how to deal the crisis of tobacco alone. That made Padrón, Latin Cigars, Plasencia Group (Segovia , the companies put a little attention to the association. Tabaco de oriente and Protanic), Esperanza Cigars,

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Natsa, Drew State, Taolisa y . Also international store of tobacco that belongs to Joya de the companies that make up boxes for cigars like Nicaragua. The scope of the alliance between two Tabaco Home and independent producers; they are firms is to maintain quality tobacco that projects both an important link in the tobacco production (Fonseca, trademarks in the international market. This would 2007). This industry generates more than a third of lead to an increase in common benefits that impact on employment in the region. the private benefits. These companies are an example of joint learning process, because both must finish In light of the theories on organization as network, the learning in order for any of them to derive the common tobacco industry in Nicaragua has formed a network benefits. organization with different actors (firms, suppliers of materials and producers); they are working to survive In this industry prior alliances are important for in an increasingly competitive market. In this context, formation of the future alliances, though it is not a the network has advantages for actors, which not only necessary condition, because the association has involves learning process and economics benefits, been maintained through the time and now whit a but the legitimation and status (Points Poldony and greater amount of companies, because the firms trust Page, 1998), as well other benefits related to funding each other. sources in common. In this sense, the organizations face a strategic interdependence within the alliance in In the tobacco industry there are two dimensions formation. positioning like in the high technology industry. However, both dimensions tend to be one, because On other hand, access to market information in this they are not differentiating. A prestige company can be network is very important, because the big firms share part of a crowded position. This is due to the fact that that information to other actors in the network. The tobacco companies in Nicaragua are concentrated in social structural in this industry have an important a region. role of social network, because the prior alliances (in 1997) prove information for new alliances (in 2006). Different elements motive to tobacco companies to The president of the association, , enter in strategic alliances such as size, age, scope, expects more companies enter in this alliance when and resource endowment. The alliances in tobacco they watch the results of the association through its industry established through the association there benefits (Fonseca, 2007). are companies of different sizes and ages, although the majorities are large companies. There are also The benefits are private and common, because in this many young companies in the industry, which they industry every company can earn unilaterally by picking has ten years of existence. With respect to resource up skills from its partner and applying them to its own endowment old and young companies do not have operations in areas unrelated to the alliance activities. greater differences. For example in 2008 as a result of a productive alliance with Drew Estate, Joya de Nicaragua managed to Recall that the company´s position in the industry close with a growth of 30% over the previous year (La affects their propensity to enter the alliance, because Gente, 2009). Common benefits are obtained from the distance and concentration are a key factor. The operations in areas of the firm that are related to the companies of the tobacco industry are in crowding alliance. For his part, Drew State has benefited from position, where exist prestigious companies that alliance in many ways; one of them is the use of the transmit some of their knowledge to other companies

25 Revista Científica de FAREM-Estelí. Medio ambiente, tecnología y desarrollo humano. Nº 10 | Año 3 | Abril-Junio 2014. within the alliance. The main goal in this industry is study a very important sector of Nicaraguan economy, to improve their performance and survive in the long since the point of network organizations. Although, the term. This performance improves with the high quality lack of sector information could not extend beyond in the tobacco and to enter in the new market. Actually, that presented in this paper. However, it can be the the main market for tobacco companies is the United basis for further study of the industry with this and States of America, followed by Europe, but their joint other approaches. strategy is to enter in Asia, without neglecting its current niches markets. REFERENCES

CONCLUSIONS Gulati, R. (1995). Social structure and alliance formation patterns. Administrative Science My purpose in this paper has been to demonstrate Quarterly, 40: 619-652. that the firms in the tobacco industry in Nicaragua Podolny, J. M. & Page, K.L. (1998). Network forms of are propensity to enter in strategic alliance. One case organization. Annual Review of Sociology: 24: 57- is the alliance between two big companies: Joya de 76. Nicaragua and Drew State. There are many factors Khanna, T., Gulati, R. & Nohria, N. (1998). The dynamics that affect the propensity to enter into alliances. The of learning alliances: Competition, cooperation, crowding position in the industry is very important, and relative scope. Strategic Management Journal, because the majority firms are in the same area (Estelí 9:193-210. department). However there are firms in prestigious Stuart, T. E. (1998). Network positions and propensities position like the companies above mentioned. to collaborate: An investigation of strategic alliance formation in a high-technology industry. The alliances network facilitates the formation of Administrative Science Quarterly, 43: 668-698. new interorganizational associations (firms, supplier Tichy, Noel M., Tushman, Michael L. and Fombrun materials and producers). The firms with many Charles (1979). Social Network Analysis for previous alliances benefit from a form of relationship Organizations. The Academy of Management or social capital that provides them with privileged Review Vol. 4, No. 4, Octubre, pp. 507-519. access to potential exchange partners. Many scholars BCN (a). 2011. Revista de comercio exterior: El have suggested that the alliances are now prevalent Tabaco. www.bcn.gob.ni in many industries and mark the emergence of a BCN (b), 2005-2010. Exportaciones fob por principales new and superior organizational architecture called socios comerciales. www.bcn.gob.ni network form. Accordingly, they have demonstrated Fonseca, Agosto 2007. El Observador Económica: that alliances can facilitate learning, enhance status El Tabaco de Nicaragua es sinónimo de calidad y or legitimacy, and contribute to organizational growth. fortaleza. www.elobservadoreconomico.com This can be evidenced between the alliance of Joya La Gente, Mayo 2009. Joya de jóvenes: 40 años de de Nicaragua and Drew State. Tabaco de Joya de Nicaragua. www.rlp.com.ni

I conclude that several concepts of the network organization are applied to the study of strategic alliance in the tobacco industry, which it has particular characteristics that could not be generalize to other industries. This paper has been a small contribution in

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